Category: credit risk

The question as to whether the benefit payable under a credit life policy can or should include arrears payments.

The purpose of a credit life policy is to protect the policyholder, the lender, and the policyholder’s estate (not necessarily in that order) against death, disability or retrenchment. This is only effectively achieved if the entire amount owing under the credit agreement is paid off by the policy.

So as a starting point, it would make sense for arrears to be included. All the stakeholders in the arrangement want this.

Back to the legal stuff

Credit Life regulations have been live for long enough now that insurers are starting to feel the impact and the shake-up of amongst industry players is starting to emerge.

There have been plenty of debate around the regulations, in part because of the dramatic financial and operational impact they will have, and partly because of how imperfectly worded they are and the scope for interpretation.

I’ll be posting about this more in the coming days.

Basing the premium on initial or outstanding balance

First, a real anomaly is the ability for insurers to charge the capped premium rate either on initial loan balance or on the declining outstanding balance.

The UK Telegraph (and other sources) are highlighting the rising panic about Euro area deflation. For those Austrian / hard money / gold standard / bitcoin / generally poorly informed amongst you, it’s not that deflation is itself a problem, but that it creates scenarios of debt spirals increasing the real value of debt obligations and decreases demand and economic growth through increasing the real cost of labour through downwards sticky prices (most especially wages).

European five year inflation expectations

It really does seem that UK / US policies are, more slowly than necessary, coming right and the economies are slowly shrugging off the GFC and are moving forwards. The rest of Europe is not.

S&P declares Argentina to be in default for the second time in 13 years and the third in 25. Inflation is likely to hit 40% this year and the Peso has already lost a quarter of its value this year, measured against the US Dollar.

Messages? This time isn’t different, sovereign debt crises happen all the time, ignore currency risk at your peril and there are many reasons governments can default on their debt.

I’ve been working with a few insurers and reinsurers on credit risk recently. We’ve had plenty of reasons to think about it, what with new regulations (SAM, Basel III) and South African government downgrades. However, sometimes I get the impression that credit risk is viewed as an academic risk, as something that happens to others, micro lenders and maybe banks.

In South Africa, we’ve had incredibly few corporate bond defaults and most market participants don’t even know that the South African government “restructured” some of its debt in 1984 and so has, in fact, defaulted on contractual bond obligations.

In a recent credit risk and capital workshop, I raised the issue of Russia defaulting on Ruble-denominated debt in 1998, a big part of what led to the collapse of LTCM. Again, these events are often figured as “exceptionally unlikely” and not even worth holding capital.

Well, in the news, Argentina is about to default. Again. They have been one of the most regular defaulters on sovereign debt in the last couple of centuries. They’re also an example I often use of “currency pegs” doing precious little to mitigate currency risk except on a day to day basis.

More on that in another post (yes, I’m hoping to post a little more regularly in the coming months.)

I’m not really that close to developments in the Chinese economy. It is a large, complicated beast that is quite different from our own. Over the last year or so I’ve heard more and more from people who generally speak sense that the debt levels in China and the awful investment projects used to show the appearance of a strongly growing economy form a worrying pair of forces.

Bitcoins are an awful idea as a currency. The 21m fixed limitation on bitcoins in a hopefully growing economy requires deflationary prices. Deflationary prices in turn discourage consumption and encourage hoarding. Low consumption and hoarding lead to low economic growth, a decreased velocity of money and more deflation.

But what about Bitcoins as an interesting speculative investment? With prices surges recently some could have made serious money. With the inevitable crash, brave souls may make money shorting Bitcoins. (but “markets can remain irrational longer than you can remain solveny” etc.)

But, the Bitcoin supporters say, if there is a 21m ultimate final supply, won’t increasing demand lead to increasing prices? Won’t this become a type of collectors’ item?

Here we run firmly into the absolute lack of intrinsic value for Bitcoins. Gold is a limited, non-corroding, shiny, vaguely useful in electronics element. It also barely has intrinsic value but at least it is truly unique.

What’s to stop someone investing Bacon Flavoured Bitcoins with a maximum supply of 21m (or any other number). A new version of Bitcoins for when the original or “Classic Bitcoins” are so tightly in demand that there is obviously demand for more of the same or similar. We could also have cheese flavoured, bubble-gum flavoured or, my personal favourite, Dutch Tulip flavoured Bitcoins.

Artificial scarcity is not true scarcity and near substitutes can be created at will.